Will Tax Cuts Boost Capital Spending?

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If the effort to cut the maximum U.S. federal corporate tax rate to 20% from 35% succeeds, will corporations reverse their current trend and allocate more funds to capital expenditures?

That question arises from the findings of the Georgia Tech Financial Analysis Lab’s report on cash-flow trends in 2017’s second quarter. 'Tax reform holds the potential to unlock cash and short-term investment balances and drive a renewal in capital expenditure spending,' the report’s authors write.

To be sure, median revenues increased to a record level of $1.5 billion as of June 2017, up 13% year-over-year from $1 billion in June 2016, according to the study of 2,610 non-financial public companies with total assets of $100 million or more.

In addition to strong sales, the researchers found cash-flow numbers that were 'suggestive of positive economic conditions,' with median cash and short-term investments growing to a record $147 million, up 8% from the $136 million reported in June 2016.

Despite the robust sales and cash figures, capex continued its longstanding tepidness, dipping from 3.93% of revenue in June 2016 to 3.74% in June 2017.

'This softness in capital expenditures continues to be a trend worth monitoring, as spending remains well-below the level of investment needed to replace capital expenditures lost during the recession,' according to the study.

The Georgia Tech report focuses on free cash flow and free cash margin. The authors define the former as 'cash flow available for common shareholders that can be used for such discretionary purposes as stock buybacks and dividends without affecting the firm’s ability to grow and generate more.' The metric is calculated as operating cash flow minus preferred dividends and net capex. Free cash margin is free cash flow divided by revenue.

The June study reports that median free cash margin decreased to 4.90% for the twelve months ended June 2017. That compared with 5.28% for the twelve months ended March 2017 and 4.64% in June 2016. 'This metric is down slightly from the last reporting period, but is still running well above pre-and post-recession norms,' the researchers say.

'Similar fluctuations in free cash margin have been seen in other periods with healthy economic growth, and this would appear to be no different,' they observe.